Gasoline Price Changes - Federal Trade Commission

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GASOLINE PRICE CHANGES: III. VERTICAL INTEGRATION IN GASOLINE MARKETS: THEORY, EVIDENCE, AND TRENDS. The extent of common ownership of different stages of production, distribution, and marketing is generally termed “the degree of vertical integration.” U.S. commercial law, with certain state law exceptions, 52 allows one firm to own all stages. In the petroleum industry, the important stages or steps include: the exploration and production of crude oil, the transportation of crude oil to refineries, crude oil refining, the transportation and storage of bulk quantities of refined products, and, finally, local wholesale and retail distribution and marketing. The degree of vertical integration – that is, the degree to which one company will perform all or only some of these steps – varies among companies in oil-related businesses. 53 See Box 5-2; see also Figure 5-9, which shows Company A as hypothetical wholly integrated petroleum company and Companies B, C, and D as companies with varying degrees of vertical integration. Box 5-2: Examples of Different Degrees of Vertical Integration Some companies, such as ExxonMobil, ConocoPhillips, Shell, and Chevron, may perform all of the steps between exploration and marketing. Others, such as Sunoco, Tesoro, and Valero, focus on refining, distribution, and marketing assets. Finally, some companies concentrate on one step. For example, Anadarko, Occidental, and Devon Energy focus on crude oil exploration and production assets; Koch focuses on refining; and RaceTrac and Sheetz focus on marketing. Upstream Downstream Figure 5-9: Examples of Vertical Integration Company A Exploration & Production Refining Terminals Distribution Gas Station Company B Exploration & Production Company C Refining Company D Terminals Distribution Gas Station This section discusses the potential procompetitive and anticompetitive effects of vertical integration, studies examining the possible price effects of vertical integration, and trends relating to vertical integration in the gasoline industry since 1990. 118 FEDERAL TRADE COMMISSION, JUNE 2005
THE DYNAMIC OF SUPPLY, DEMAND, AND COMPETITION A. Vertical Integration May Be Cost-Effective for a Firm. As a general matter, firms may integrate vertically – that is, own assets to perform more than one step in the production, distribution, and marketing of a good – because integration can lower costs. In certain circumstances, vertical integration can (1) reduce transaction costs; (2) prevent contractual partners from taking advantage of a firm; (3) eliminate double markups and thereby increase overall demand for a product; and (4) eliminate distortions of input choices when a supplier has market power. 54 1. Reduce transactions costs. When two separate firms enter into a supply relationship, they must negotiate the terms of that supply relationship. For example, the two firms must agree on and enforce prices, quantities, and other terms of trade. Such contract negotiations cost money in terms of personnel time, legal advice, and other matters. Vertical integration can reduce such transactions costs, if it is easier to establish these terms through direct managerial control of two business units than through either (1) long-term contracts, or (2) repeated, arm’s-length transactions with firms selling in spot markets. 55 If the mutually beneficial terms of the trade between two vertically related business units are complex, and it is difficult to specify all future contingencies within a contract, using direct managerial control is likely to reduce transactions costs below those associated with contractual relationships. 2. Prevent opportunism by contractual partners. To prevent contractual opportunism means to eliminate the risk that one party to a contract will take advantage of the other. This can happen if a contract is “incomplete” – that is, the contract fails to specify the rights and obligations of the parties in all possible circumstances. When a contract is incomplete, unforeseen circumstances may allow one of the firms to benefit unduly from the terms of the contract. This type of risk tends to be more significant when potential contract partners need to invest in specialized assets to create the value resulting from the proposed contract. For example, a very heavy grade of crude oil might require special, longlived investments in refinery-processing equipment to produce high-value refined products. These special investments, however, may have relatively little value in processing other types of crude oil. Therefore, to make such investments worthwhile, a refiner would need a reliable source of heavy crude oil. To rely on a long-term supply contract with a producer of heavy crude oil, a refiner typically would require the contract to be sufficiently complete. To negotiate a sufficiently complete contract may be very costly, however. If a sufficiently complete contract could not be negotiated, vertical integration between the very heavy crude oil producer and the refiner might be required to achieve the transaction. CHAPTER 5: STATE & LOCAL POLICIES, & VERTICAL INTEGRATION 119
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Federal Trade Commission DEBORAH PL
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GASOLINE PRICE CHANGES: The vast ma
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GASOLINE PRICE CHANGES: $ The World
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GASOLINE PRICE CHANGES: expect incr
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GASOLINE PRICE CHANGES: Figure 3-6:
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GASOLINE PRICE CHANGES: $ Increased
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GASOLINE PRICE CHANGES: $ Since 199
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GASOLINE PRICE CHANGES: increase lo
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GASOLINE PRICE CHANGES: England and
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Table of Contents EXECUTIVE SUMMARY
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C. In 2004, the Geopolitical Outloo
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CHAPTER 4: SUPPLY, DEMAND, AND COMP
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3. Gasoline prices in the East Coas
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CHAPTER 1. SUPPLY (INFLUENCED BY OP
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To obtain the additional supply the
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THE DYNAMIC OF SUPPLY, DEMAND, AND
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Price (Cents per Gallon) 220 200 18
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words, short-run demand for gasolin
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Endnotes THE DYNAMIC OF SUPPLY, DEM
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CHAPTER 2. WORLDWIDE SUPPLY, DEMAND
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Thousand Barrels per Day 18,000 16,
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Million Barrels per Day 0.9 0.8 0.7
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such as ethane, ethylene, and propa
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CHAPTER 3. SUPPLY, DEMAND, AND COMP
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Year-over-year Percentage Change in
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Capacity (Million Barrels per Calen
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Endnotes THE DYNAMIC OF SUPPLY, DEM
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Page 99 and 100: Price Difference (Cents per Gallon)
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Page 111 and 112: Millions of Barrels per Day 9 8 7 6
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Page 137 and 138: Share (Percent) 80 70 60 50 40 30 2
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Page 165: Herfindahl-Hirschman Index (HHI) Th
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Gasoline Price Changes - Federal Trade Commission

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